International Finance

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(No Transcript)
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International Finance

• Session 1 Introduction
• Dick Sweeney

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Introduction

• Whats different about International Finance?
• Multiple currencies, exchange rates , , , ,
  baht, rupiah, yuan, krona, krone,
• International financial markets--everywhere and
  nowhere (London, Tokyo, BahrainChp. 4, on
  reserve)
• Multiple governments, laws, languages, cultural
  environments (e.g., U.S., Indonesia)
• Exponential complexity
• Not 10 x 2, but 10 2

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Survival Guide

• But you already know a lot about finance most
  (not all!) transfers over to international
• Look again at the introductory figure
• Random walks (approximately) in both stock
  markets and FX markets
• What does random walk mean, exactly?
• Other examples of similaritiesand differences

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Comparison of Stocks and Exchange Rates

• Stocks Exchange Rates
• Prices look like Prices look like
• random walks random walks
• Returns are pretty Returns are pretty
• close to random close to random
• Systematic risk, Systematic risk,
• Non-systematic risk Non-systematic
  risk

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Comparison of Stocks and Exchange Rates (cont.)

• Stocks Exchange Rates
• Returns depend on Returns depend on
• betas, risk factors betas,
  risk factors
• Average market beta unity Average market
  beta zero
• Typical stocks beta Typical
  exchange rates beta
• fluctuates around unity fluctuates around
  zero
• Standard deviation U.S. Standard deviation
  USD,
• stock market, 4.33 to 2.9 to 3.5 per
  month for
• 5.77 per month most currencies

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Exchange-Rate Risk

• How big is FX risk?
• Sigma (?)? ? 3.3 per month?
• Beta (?)? 0.0? ? 0.10? ? 0.20?
• Which risk matters for you? for client?
• What can you do about risk?
• Hedge ? eliminate risk
• Portfolio choices (diversification) ? reduce risk
  on average

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Exchange Rate Risk (cont.)

• Open exchange rate positions are risky
• Whats the risk-return trade off?
• Deposit in Euros vs. in USD
• ?St1/St ieur,t vs. iusd,t
• ?St1/St ieur,t - iusd,t excess return
• E ?St1/St ieur,t - iusd,t expected excess
  return
• E ?St1/St ieur,t - iusd,t ?t (E RM,t -
  iusd,t)
• E ?St1/St ieur,t iusd,t ?t (E RM,t -
  iusd,t)

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What do firms do about risk?

• Derivatives used by 59 of large firms, 13 of
  small firms in U.S.survey
• FX derivatives 76 of derivative users
• Which FX derivatives? 75 forwards, 50 options
• Contractual exposure (receivable, payable) 86
  forwards, 7 options

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Goals of Course

• The basics about FX markets, how they are
  organized and work, their main products
• Know the basics of FX risk management
• Know how to analyze FX problems
• Know how to choose which tools to use
• Know how to solve FX problems
• In-depth review of analytical tools

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Role of Concepts
Numbers
Decision
Concepts, Theory
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Topics and Time Allocation
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Analytical Techniques
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Parity ConditionsPercent of What You Should Know
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Short Meeting-by-Meeting Outline

• Weds., Jan. 10 Introduction
• Mon., Jan. 15 Martin Luther King, Jr., Holiday
• Weds., Jan. 17 Behavior of nominal exchange rates
• Mon., Jan. 22 Behavior of nominal exchange rates,
  cont.
• Weds., Jan. 24 The Foreign Exchange Market and
  Its Mechanics
• Mon., Jan. 29 The Foreign Exchange Market and Its
  Mechanics
• Weds., Jan. 31 The Foreign Exchange Market and
  Its Mechanics, cont. (Prob. 1 is due)

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Short Meeting-by-Meeting Outline

• Mon., Feb. 5 Technical Analysis and Evaluating
  Profits
• Weds., Feb. 7 Technical Analysis and Evaluating
  Profits, cont
• Mon., Feb. 12 Technical Analysis and Evaluating
  Profits, cont.
• Weds., Feb. 14 Introduction to Covered Interest
  Arbitrage
• Mon., Feb. 19 Presidents Day Holiday
• Weds., Feb. 21 SEBank (B) case (case write-up is
  due).
• Mon., Feb. 26 Mid-term, in class

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Short Meeting-by-Meeting Outline

• Weds., Feb. 28 Introduction to Hedging.
• Mon., March 5 Spring Break
• Weds., March 7 Spring Break
• Mon., March 12 e-Mother case (case write-up is
  due)
• Weds., March 14 Foreign-Exchange Decisions, I
  The Decision Maker Is Diversified (Prob. 2 is
  due)
• Mon., March 19 Foreign-Exchange Decisions, I The
  Decision Maker Is Diversified, cont. (Prob. 3
  is due)
• Weds., March 21 Comparison of CIP and UIP
• Mon., March 26 Baggins Co. case (case write-up is
  due)

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Short Meeting-by-Meeting Outline

• Weds., March 28 Foreign-Exchange Decisions, II
  The Decision Maker Is Not Diversified
• Mon., April 2 Foreign-Exchange Decisions, II
  The Decision Maker Is Not Diversified (cont.).
• (write-up of Chat Shipping and Handling (A)
  case is due)
• Weds., April 4 Foreign-Exchange Decisions, II
  The Decision Maker Is Not Diversified
  (cont.).
• (write-up of Chat Shipping and Handling
  (B) case is due)
• Mon., April 9 Behavior of Real Exchange Rates
• Weds., April 11 Behavior of Real Exchange Rates,
  cont. (valuation examples)

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Short Meeting-by-Meeting Outline

• Mon., April 16 Easter Break
• Weds., April 18 Behavior of Real Exchange
  Rates, cont.
• (which model is better? Prob. 4 is due)
• Mon., April 23 Real Rates and Valuation. (case
  write-up is due)
• Weds., April 25 Guest Speaker, Mr. Ira Kaylin,
  IDB (tentative!)
• Mon., April 30 Review Session, in class

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The Euro A First Look

• Born Jan. 1, 1999--rocky 7 years
• Euro as currency started Jan. 1, 2002
• What can be expected?
• In concrete, quantitative terms in next month?
• In general terms over next several years?
• Look at history of DEM during float
• Large ups and downs
• Euro looks normal compared to history

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143
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The Euro Looks Like a Random Walk
63.9
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Regression Output

• Dependent Variable LNEURO
• Method Least Squares
• Sample 2 1741
• Variable Coefficient Std. Error t-Statistic Prob.
    
• C 0.000181 0.000167 1.085198 0.2780
• LNEURO(-1) 0.999666 0.001004 995.4134 0.0000
• R-squared 0.998249     
• Durbin-Watson stat 1.99674

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Cant We Make Money From This?
Scatter Diagram
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Moving Average and Speculation
MA
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USD/DEM Appreciation Rate